Activity Based Costing
Activity Based Costing (ABC) is a cost accounting method that identifies and assigns costs to specific activities in an organization. It provides a more accurate way to allocate costs by linking them to the actual activities that drive those costs. By understanding the cost drivers, ABC helps in making informed decisions about resource allocation and process improvements.
7 Key excerpts on "Activity Based Costing"
eBook - ePubBusiness
The Ultimate Resource
- Bloomsbury Publishing(Author)
- 2011(Publication Date)
...Calculating Activity Based Costing GETTING STARTED Activity Based Costing (ABC) attempts to create the big picture—crystal-clear, full, and accurate—by painting assorted little pictures. • ABC identifies the relationship between a business activity and all the resources needed to conduct it by assigning costs to each of those resources, thus presenting the true total expense of the entire activity. • ABC can account for so-called “soft” or indirect operating costs, and thus produce a more revealing, and perhaps startlingly different, financial picture than other accounting methodologies such as standard costing might offer. • Used properly, ABC helps management better to distinguish operations that add value from those that do not, permitting more informed decisions about such matters as pricing, product mix, capital investments, and organizational change. • In turn, ABC’s advocates praise it as a more effective tool to identify and control costs, improve productivity, and increase profits. FAQs When did ABC start? ABC came of age in the 1980s amid manufacturers’ furious efforts to raise the quality of their products while simultaneously eliminating every unnecessary cost from their operations...
eBook - ePub- Andrea Kennedy, Andrea Reyes, Francesco Venezia(Authors)
- 2020(Publication Date)
- Bloomsbury Visual Arts(Publisher)
...5 Activity-Based and Product Development Costing Activity-Based Costing Activity-Based Costing (ABC), is a costing method that assigns a monetary value to each and every production activity and overhead expense. It differs from simply calculating your overhead expense as a percentage. ABC places each indirect activity, duty, and cost into categories. In allowing each activity/expense to be categorized, line items have greater precision and accuracy in costing data and management. ABC is complex; it is laborious and can be confusing because it is data- and time-intensive. As opposed to calculating one overreaching overhead percentage, all item types are tracked and costed separately. Many apparel companies feel the collection of all the necessary data is too detail-oriented and time-consuming. Occasionally, those interested in applying ABC start, but then forego the process and go back to a percentage when they experience the level of detail involved in breaking down the cost. ABC involves breaking down many activities, operations, and duties to the minute, and dividing them by total overhead, administrative, and payroll costs. A true cost is accounted for in ABC as there is fairly full transparency in this methodology. However, as stated, many hesitate to utilize this costing methodology due to the time and labor involved in tracking each activity. They decide that ABC costs more than the value and costing transparency gained. Let’s look closer at the details of ABC. ABC assigns costs to types of manufacturing activities that are traditionally not on a cost sheet, and may or may not be on the Overhead Costs Tracking Sheet. Activities such as material handling, machine set-up for new production batches, and maintaining and repairing equipment are all activities that are included in manufacturing and are often are omitted from the cost sheet...
eBook - ePub- Nathalie Evans, Michael Jeffrey, Susan Craig(Authors)
- 2020(Publication Date)
- Bloomsbury Visual Arts(Publisher)
...Thus some ways of driving those costs into the product are required, as overhead absorption, based on direct labour or even machine hours, is simply not an option. Activity-based costing The essence of ABC is that products or services themselves do not create cost; it is the activities that the business engages in that create cost. The product or service is a user of those activities and the more activities a product uses, the more cost it will have to bear. ABC tries to relate overhead to the activity that causes or drives the cost, referred to as cost drivers. Costs with the same cost driver are grouped together in cost pools and an appropriate cost driver rate is then used to develop the product cost. Figure 13.1 Activity-based costing process. This is in contrast to traditional absorption costing where overheads are allocated to departments or cost centres where a single cost centre rate is used for all overheads in that cost centre to achieve the product costs irrespective of what activity has caused the overhead. Typical activities and their possible cost drivers: Table 13.1 Illustration comparing ABC to traditional absorption costing Auto Wear Overalls manufacture disposable overall in an advanced manufacturing environment with minimal direct labour input...
eBook - ePubReturn on Investment Manual
Tools and Applications for Managing Financial Results
- Robert Rachlin(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...15 How to apply Activity-Based Costing for Improving ROI Activity-based costing (ABC) approaches a strategy based on a customer’s needs and the competition between various services of a company. The link between activity-based costing and return on investment is based on providing a more effective way of measuring and allocating resources to effectively increase earnings and, thus, return on investment performance. We saw in the previous chapter how direct and absorption costing differs from conventional accounting principles. For example, under absorption costing, more overhead expenses are allocated as production increases. This is in spite of those products produced that may need a greater proportion of overhead expenses from service departments such as engineering and purchasing. To overcome this inequity, activity-based costing associates costs with specific activities used to create these costs. It is based on the idea that any good or service needs organizational structures to perform the necessary activities, which in turn incur costs. This costing system recognizes costs that are not directly attributed to the flow of a product/service into a required activity. The cost of each activity eventually flows into the product cost. An Example of Allocating Indirect Costs Using Activity-Based Costing ABC costing uses a different method of allocating indirect costs. It assigns direct costs to specific production units, and indirect costs based only on direct labor hours or the volume of production. Illustration For example, let’s assume the following facts for an engineering department: Note: The total direct labor of both product X and Y is $60,000, and the cost of operating the engineering department is $6,000...
eBook - ePubThe Logistics and Supply Chain Toolkit
Over 100 Tools for Transport, Warehousing and Inventory Management
- Gwynne Richards, Susan Grinsted(Authors)
- 2020(Publication Date)
- Kogan Page(Publisher)
...08 Financial management tools and ratios 8.1 Activity-based costing (ABC) and time-driven activity-based costing (TDABC) Introduction ABC is a financial cost accounting model. It differs from traditional finance models as it attempts to allocate all costs, including overheads, directly to each product, activity or customer. Traditional cost accountancy models allocate indirect costs or overheads on the basis of volume or as a percentage of total direct cost. In a traditional costing model, all products and customers are allocated the same percentage overhead irrespective of activity, such as management time spent on them. As a result, low-volume products and smaller customers are not always allocated the true cost of producing or servicing them. This can result in under-priced products and customers being either under- or overcharged. This became very apparent to the author when he became customer services manager for a leading 3PL. With over 25 clients, it always seemed to be the smallest client that took up a large percentage of time, rather than the large corporate clients – yet costs were spread across the clients, based on their volume of business. This becomes more difficult when we look to allocate costs such as the human resources, finance, sales and marketing, IT, and health and safety departments. ABC assigns the cost of each activity in an organization to all products, services and customers according to the actual consumption of the resource. The main drawback to ABC is the time it takes to gather all of the information and to accurately allocate the indirect and overhead costs. A further drawback is the fact that not all costs can be allocated precisely. With this in mind, Kaplan and Anderson (2004) came up with time-driven activity-based costing, which will be discussed in the last section of this tool. When to use This tool is for companies that want to be more accurate in terms of allocating costs...
eBook - ePub- Nicholas Apostolides(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...9 Activity-based costing (ABC) Chapter overview We have seen how overheads are normally recovered by linking them to direct hours worked – even though the two are not always connected. In the1980s two American academics, Robert Kaplan and Robin Cooper, queried this relationship. They felt that basing the treatment of overheads, which are primarily fixed, on labour or machine hours provided convenient arithmetic but took too little account of how the costs included were incurred. The commonly accepted overheads/direct hours connection was, in their view, a spurious one. Nowadays, direct labour hours make up only a small proportion of organizational costs and machine hours comprise a much smaller one, even in manufacturing enterprises. Fixed costs dominate most organisations’ cost structures, and this dominance – in an age when managers are trying every trick to reduce expenses – needs a far better explanation than the simple assertion that fixed costs are not affected by the volume of production. This chapter examines the use of activity-based costing, an approach which seeks to establish a more reliable and representative basis for tracking and controlling costs. Identifying cost drivers The key to the ABC approach is to identify the cost drivers of the activities of a business – in other words, the activity-related factors that generate the business’s costs. Think of the various activities associated with the materials used in a manufacturing business, such as storage for instance. The physical volume of materials stored is likely to be a main driver of warehousing costs and, as such, is a driver of storage overheads. ABC subjects all the factors affecting overheads to close analysis...
eBook - ePubCurrent Topics in Management
Volume 13, Global Perspectives on Strategy, Behavior, and Performance
- M. Afzalur Rahim, M. Afzalur Rahim(Authors)
- 2018(Publication Date)
- Routledge(Publisher)
...12 Activity Based Costing in the Financial Sector: New (and Powerful?) Accounting Discourse and Practice Rui Vieira Continuous changes in the organizational environment have made organizational change a key research issue. In recent years, the accounting literature has focused increasingly upon the ways in which accounting practices interact with and even shape organizational change, particularly after the call for new more “relevant” management accounting systems (MAS) made by Johnson and Kaplan (1987). Since Johnson and Kaplan published Relevance Lost: The Rise and Fall of Management Accounting, where they discuss the new manufacturing environment and the inadequacies of traditional MAS and set out prescriptions for the future, activity-based concepts have spread rapidly, especially through management consultants and practitioner publications. Nevertheless, their claims have been disputed. Motivated by a problem-solving approach, there has been a tendency to offer quick solutions to problems that have not been fully analyzed and understood. At a theoretical level some consensus exists that Activity Based Costing (ABC) is superior to traditional cost systems (e.g., Brimson, 1991 ; Brinker, 1991, 1993, 1994). Nevertheless, at a practical level, many problems arise when firms attempt to implement ABC systems. Researchers have addressed this inconsistency between theory and practice by shifting the focus from technical issues to the effect that behavior issues have on ABC implementation. The traditional focus in accounting research had portrayed accounting change as an outcome of rational behavior to maximize profits through better information. This has given way to, or been supplemented by, an increasing range of research into the “complex (and often unpredictable) dynamics of change through time” (Burns, 2000, p. 568). Where Pettigrew (1990) had accused conventional research of being: “ahistorical, aprocessual and acontextual in character” (p...
